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MACROECONOMIC SITUATION: UNCONTROLLABLE CORRECTION
Dzmitry Kruk
Summary
The year 2011 saw Belarus start cleansing itself of the accumulated macroeconomic imbalances, which proved to be a painful procedure. The overheating of the Belarusian economy in late 2010 and early 2011 and current disproportions overlapped with structural problems thus necessitating macroeconomic adjustments. Because the authorities were not ready to impose economic restrictions, the correction became automatic, and equilibrium was attained mostly through inflationary processes and ruble devaluation. This created new stimuli in the economy for all agents, the result being that external demand grew stronger than that internal, while the sector-wise production pattern was marked by changes in favor of export-oriented enterprises. Household incomes became one of the chief macroeconomic "compensational" variables - they were slashed in a bid to rid the economy of imbalances. The automatic correction turned into a "purging" procedure, which provided a chance for a more balanced development. However, it does not guarantee future sustainability, because sustainable growth is secured by fundamental factors rather than short-term price-based factors of competitiveness.
Trends:
• The currency crisis was caused primarily by structural problems in the Belarusian economy;
• The disregard for accumulated imbalances and expansionary policy stood behind the automatic (uncontrollable) nature of macroeconomic adjustments;
• Because of the automatic correction, the economy went through a sort of a purge, ridding itself of the most acute imbalances;
• Some structural disproportions still remain, impeding sustainable development in the future;
• Belarus achieved macroeconomic stabilization by way of cutting the incomes of Belarusian households, which suffered the most during the crisis.
Introduction
Belarus moved into the year 2011 with a full package of structural imbalances. Some obvious predicaments of the national economy included its chronic external deficit, shortage of savings to finance investments, excessive risks in the banking sector and growing debt burden. But all of these disproportions became outward manifes-
tations of even more crucial problems, such as the low return on investments and low efficiency of the allocation of resources, which curb the economy's growth potential. We believe that the reduction in potential growth rates should be attributed to the specific structural policy measures that are typical of the "Belarusian model", namely, the administrative distribution and redistribution of resources; direct regulation of prices, interest rates and compensations; and promotion of productivity through the stimulation of internal demand.
The said problems did not emerge out of the blue, but had been accumulated during a long period of time; however, their adverse effects were successfully mitigated with the use of various instruments. The situation had changed by 2011, though. Efficiency losses and low return on investments became more conspicuous, as their scope depends on how long the distorting structural policy instruments are used. The positive impact of the privileged status in the country's relations with Russia dwindled compared with 2003 — 2008. Access to external borrowing on favorable terms markedly narrowed, as most of the obvious cheap borrowing possibilities had already been exhausted.
Finally, it turned out that short-term instruments were not good enough anymore to keep the economy "afloat". First, the stimulating policy resulted in an aggravation of structural imbalances in 2010 (especially in the second half of the year)1, including the expansion of external deficit, shortage of sources to finance investments and deterioration of the quality of bank assets. Second, this policy brought about new problems — the accumulation of inflationary potential and deterioration of companies' price competitiveness resulting from the growing labor unit costs. Therefore, if this stimulating policy had continued, its effects would inevitably have been neutralized by inflationary and devaluation processes, which take the real indicators back to the long-term equilibrium level. Third, when pursuing their stimulating policy in 2009 — 2010, the economic authorities made use of nearly all of the available resources. As a result, the country's gold and foreign exchange reserves markedly
This is due to the fact that early in 2011, the economy reached its potential, i.e. overcame the recession and recovery phases. Whereas stimulating policy is well justified during the recession phase, when its negative consequences are relatively insignificant, then justifying this policy during the expansion cycle is quite difficult. In the latter case, this policy will inevitably lead to a faster increase in consumer prices and additional demand for imports.
dwindled, whereas the "room for maneuver" in the fiscal sector narrowed.
Therefore, in early 2011, the short-term disproportions overlapped with more serious long-term problems that emerged in previous years, thus causing the latter to manifest themselves. Moreover, the situation being what it was, the authorities had few levers to resist the shocks, because a substantial part of the potential of economic policy instruments had been exhausted during the previous two years.
Macroeconomic dynamics
The economic authorities not only ignored the need to establish a restrictive policy, but also tried to continue stimulating the economy despite the obviously exhausted potential of expansion policy instruments. Because they could not gain access to sufficient volumes of new external borrowing, the economic authorities started encouraging domestic demand using chiefly monetary instruments, i.e. by way of money issue, which unfailingly spurs inflation and puts additional pressure on the currency market. The authorities more or less succeeded in anchoring prices at the start of the year, including through the use of administrative levers; however, in the money market, administrative measures resulted in multiple exchange rates.
Eventually, it was the exchange rate that became the chief balancing parameter for the economy once the government failed to apply restrictive measures to consumption and investments. In other words, the macroeconomic correction, necessitated by long-and short-term imbalances was mostly through changes in the exchange rate, automatic and uncontrollable.
Under this macroeconomic correction scenario, external equilibrium is rapidly restored in the first place, and then the real volume of the domestic demand components is gradually adjusted through inflationary processes. It is because of the automatic unregulated achievement of external equilibrium and the fact that the exchange rate was used to perform the balancing functions, thus substituting for other economic instruments, that the ruble depreciated against the basket so much in 2011 (the nominal effective exchange rate dropped 65%, and the real exchange rate fell 28.3% last year, and those were not bottom values recorded throughout 2011).
Despite its painful effects, including the high inflation rate, reduction in real household incomes, growing poverty level, etc.,
the currency crisis purged the country of short-term disproportions. The large-scale devaluation of the ruble sent out new price signals to exporters and importers; therefore, there were improvements in net export dynamics starting the second quarter, and as early as the third quarter of 2011, net exports were out of the negative zone (in nominal terms), turning into the GDP growth locomotive. One of the most pressing problems of the national economy — the extern deficit — was thus resolved through ruble devaluation.
It must be emphasized again that the main reasons for the chronic external deficit were structural imbalances; therefore, the devaluation move only helped resolve the problem temporarily, giving the country a short-term break. In order to secure net exports close to or just above zero, a structural reform is necessary; otherwise Belarus will have to keep devaluating its currency on a regular basis.
The chief components of domestic demand — household consumption and gross fixed capital formation — were also markedly modified. Both components showed an impressive growth in the first quarter amid the ongoing stimulating policy, whereas in the second quarter, this growth slowed down as a result of money market shocks. In the second half of the year, the slump was already caused by inflationary and devaluation processes and measures to restrict the financing of capital investments that the government eventually chose to take. Therefore, the GDP structure underwent significant demand-related changes (deemed positive from the point of view of long-term prospects), as external demand substituted for a part of internal demand.
Overall, GDP grew 5.3% year-on-year in 2011; however, the growth was not uniform. The economy expanded 11.2% year-on-year in the first half of 2011, while in the third quarter, GDP only grew 1.9% from the same period in 2010, and in the fourth quarter, there was no change from October-December 2010.
The automatic correction mitigated another structural imbalance — the shortage of savings to finance investments. This process was taking place in the second half of the year, mostly through reducing the share of investments in GDP. However, the problem was never completely resolved, because most of the funds saved as a result of investment cuts were accumulated in the state budget, which was implemented with a surplus in real terms due to expenditure restraints.
Overall, the year 2011, especially its second half, can be characterized as a period of painful cleansing of accumulated macro-
economic disproportions, which reduces the susceptibility of the economy to some external shocks and gives it a chance to grow at a higher rate and show sustainability in the future on the condition that relevant institutional obstacles are removed by way of structural reforms.
Real sector
The new stimuli that appeared as a result of the large-scale consumer inflation and ruble devaluation affected nearly all groups of economic agents. The main trend observed in the real sector of the economy was the change in the sectoral makeup of production in favor of export-oriented industries. This trend was most conspicuous in the processing industry, which showed a 10.1% growth year-on-year (while GDP expanded 5.3%). These impressive results were largely due to the excellent performance of the following sectors: the production of vehicles and equipment and the production of machines and equipment.
The high growth rates in these sectors should be attributed primarily to the recovery of demand in foreign markets amid the new price edge. Oil refining contributed the most to the growth of the processing industry — the increase in oil product output was caused for the most part by improving terms of trade in oil and refined oil compared with 2010 rather than the devaluation of the national currency.
The country's agribusiness showed an impressive growth, while in construction, growth slowed to 4.9% year-on-year from 15.3%. The trends in the construction sector, as in all the other sectors working primarily for the domestic market, were driven by changes in consumer prices and ruble devaluation, which affected the spending capacity of households acquiring construction services. The tightening of preferential home construction mechanisms, a desperate measure that the government had to take in a bid to improve the economic situation, became another important factor that produced a negative impact on the construction sector.
In the service sector, financial business and the article "indirectly calculated financial intermediation services" grew faster than other segments, mostly because commercial banks were able to respond to changes in the economic situation fast and effectively by way of changing interest rates and generated high profits from currency exchange operations and related transactions. Other segments of
the service sector showing a relatively high growth rate were retail and repairs, transport and telecoms — these are traditionally connected with foreign trade, meaning that they benefited from the devaluation of the ruble. Other service industries catering mostly for the domestic market either grew very modestly or reduced output.
When it comes to the financial standing of Belarusian enterprises, the same sector-wise trends were observed — the financial performance of export-oriented enterprises improved, and the same holds for the businesses that managed to make use of inflationary and devaluation processes domestically. The growth leaders in terms of their profitability were financial, real estate and manufacturing companies.
Inflationary and devaluation processes had an overall positive effect on profitability figures through reductions in labor unit costs (prices were growing faster than wages). Furthermore, during the periods when the Belarusian ruble was losing most of its value (late summer and early autumn), most Belarusian industries saw reductions in inventories, which also had a positive effect on companies' finan-cials. As a result, the average sales margin in the economy amounted to 13.2% in 2011, up from 7.3% in 2010, and return on sales reached 10.3%, an increase from 6%.
Households
Average household incomes figures for 2011 look quite attractive despite the economic environment: last year, incomes went down only 0.7% year-on-year (real disposable incomes decreased 1.6%). However, if we take a look at the dynamics of household incomes at the start and the end of the year, the slump in real incomes will be obvious. In January 2011, real monetary incomes went up 25.4% year-on-year, whereas in December 2011, they fell 17.7% from previous December. If we break down annual incomes by months starting January 2011, then November 2011 became the bottom, with incomes falling 14% from January 2011 in real terms.
The makeup of monetary incomes was also markedly modified — the share of compensations rose 2.3 percentage points to 65.4% of all incomes, while the shares of incomes from business and transfers went down 1.4 percentage points and 0.9 of a percentage point, respectively. The reduction in the share of transfers to the population in the structure of incomes resulted from conservative budgetary policy in the social sector, as social expenditures were adjusted
much slower than prices grew in nominal terms. Therefore, the least protected population groups (pensioners, large families, etc.), for whom social transfers remain the main source of incomes, were affected the most by the reduction in welfare payments.
Administrative price caps that the economic authorities imposed many times throughout the year helped support the population — price regulations enabled the authorities to slow down inflationary processes and mitigate the effects of the slump in real purchasing power.
External sector
External commodity trade deficit has remained the country's chronic problem for many years and became an important factor contributing to the currency crisis. Up until the acute phase of the currency crisis at the end of the first quarter, foreign trade trends repeated the pattern established in previous years: imports were growing much faster than exports. Merchandize imports increased for all commodity groups — investment, intermediate and consumer goods) — encouraged by the rapidly growing internal demand, which provoked hikes in the demand for imported commodities, and overvalued national currency. Besides macroeconomic factors, imports were also promoted by the willingness of many Belarusian households to acquire imported automobiles prior to July 1, 2011, when new customs duties on vehicle imports were to be set. The overvalued real ruble exchange rate and discouragement of exports resulting from the artificial promotion of internal demand affected export growth rate. In the first quarter of 2011, Belarus also faced problems with foreign supplies of oil products, as the county had failed to come to a compromise with Russia over the amount of premium paid to crude oil suppliers following changes in the terms of oil trade in 2011.
External trade problems were further aggravated in the first quarter by the accelerating trend towards outflows of foreign exchange as incomes on previous investments — this was caused by peculiar methods to attract investments in previous years. By April 1, 2011, Belarus' current account deficit had reached a new all-time record of 24.2% of GDP (USD 3.4 billion in absolute terms). This deficit was only partially financed by surpluses of the capital and financial accounts. The most significant inflows included the receipts from floating USD 800 million Eurobonds in January 2011,
new loans totaling USD 837 million and reinvested earnings amounting to USD 586 million. The shortage of sources of financing brought about the exhaustion of the liquid part of international reserve assets, triggering ruble devaluation processes (which initially took the form of multiple exchange rates).
After the NBB stopped containing the market exchange rate of the national currency, foreign trade trends reversed. In the second quarter, exports were already growing much faster than imports.
The main contributors to the growth in Belarusian exports were meat products, ferrous metals, road and construction machines, metal-working machines, tractors, trucks and tractor units. Also in the second quarter, exports of refined oil products produced a favorable impact on Belarus' foreign trade balance — despite the USD 45-per-tonne premium that Russian oil majors imposed on deliveries to Belarus, the conditions of oil procurement, processing and re-export were more favorable than in 2010.
The slower import growth during that timeframe should be attributed to the limited supplies of intermediary non-energy and investment products, as well as foods. The relatively small current account deficit recorded in the second quarter, at USD 1.1 billion, was fully financed from new loans (especially the first installment of the EurAsEC loan, amounting to USD 800 million) and some other minor financial account inflows.
In the third quarter, the real exchange rate of the Belarusian ruble reached its all-time low (in August) which spurred the second-quarter trends: exports kept growing, while imports slowed and even went down for some commodity groups. Consumer imports decreased the most compared with the second quarter because vehicle imports dropped as soon as the new duties were introduced. As for other consumer goods, their imports went down following a reduction in households' purchasing power (this is especially true for imported goods). The result was a current account surplus, at USD 51.7 million, recorded in the third quarter of 2011 for the first time in years.
The fourth quarter was marked by a landmark event in the national economy, when Belarus finally tightened its monetary policy and introduced the single ruble exchange rate. Furthermore, Belarus managed to secure sufficient investment inflows, including USD 2.5 billion in receipts from the sale of the remaining 50% in OAO Beltransgaz and a USD 1 billion loan from Sberbank of Russia, extended to OAO Belaruskali against the security of OAO Naftan
refinery shares. The panic demand for foreign exchange subsided once the unified exchange rate was introduced, and increase in deposit rates at the end of the year (both in nominal and real terms) boosted the demand for Belarusian rubles.
Overall, the above factors preconditioned the stabilization of the nominal exchange rate of the Belarusian ruble and even led to the strengthening of the national currency in the fourth quarter (compared to July-September) in real terms amid the continuing price increase, which gained momentum during previous periods. Nevertheless, given the debt problems in the Eurozone, which created a negative background in the global economy, Belarus saw the terms of trade for some of its commodity groups deteriorate, therefore, exports grew slower in the fourth quarter compared with the previous three months, and a USD 1.3 billion commodity trade deficit was registered.
All in all, commodity trade deficit amounted to USD 5.5 billion in 2011, down 43.2% year-on-year. This welcome reduction was caused by the 59.4% rise in exports, which was almost twice the increase in imports (31.1%). To have a better picture of the effect of the ruble devaluation on the country's foreign trade we should eliminate some intermediate materials from the trade statistics — exports rose 16.9% year-on-year in real terms (minus oil products and potash fertilizers), and imports went down 7.4% (net of oil, oil products and natural gas). These foreign trade tendencies stood behind the USD 5.7 billion current account deficit financed from foreign sources and privatization revenues. The latter also enabled the economic authorities to increase international reserve assets.
